This makes me expect a short term relief rally. Sentiment is also reflecting quite a bit of pessimism - more about that in tomorrow’s weekly sentiment overview. But I don’t expect such a rally to be very strong or sustained.

And the bounce arrived right on cue taking the S&P 500 index higher by about 80 points and almost reaching 1100. The rally ended abruptly last Friday with most indexes dropping sharply. From the looks of it, we’re setting up for yet another lower high after quite a few lower lows and lower highs.

This is the definition of a downtrend and we can see the same general pattern emerge if we look at breadth indicators like the percentage of stocks above a moving average. I’ve referred to the longer term breadth measure (percentage of S&P 500 components above their 150 moving average) more than a few times. The most recent was when I mentioned that while current breadth was bad, it usually gets worse. Here is a zoomed in version of the same chart I showed in that previous message:

Everything was going relatively well with the vast majority of stocks trading above their longer term average but then came along the May 6th “Flash Crash”. That started the trend of lower lows and lower highs for this breadth indicator. It may be a bit difficult to see on the chart but the January 2010 top was slightly under the highs of September 2009 and the April 2010 top was slightly under the one from January 2010.

The most recent bounce from the start of this month has only continued that pattern. If it does continue, then the historical norm is for it to eventually go below 10%. To see a longer term chart showing previous times we’ve fallen to these low levels, check out: When Breadth is this bad, it usually gets worse.

The same pattern of lower lows and lower highs can be seen in the cumulative advance decline lines for both the S&P 500 index and the NYSE. So overall, I’m not really seeing any technical reasons to expect anything other than continued weakness.

From the sentiment data, the thing that concerns me is that generally speaking, sentiment is too quick to shift back to the bullish side. We did see some genuine fear and loathing at the end of June and early July in the NAAIM and AAII indicators. But then both of them quickly jumped on the rally bandwagon and forgot their worries.

A break in this pattern of lower lows and lower highs would certainly change the tone of the market. But that all depends on what sort of market we find ourselves in at the moment. One of the first steps traders and investors take is using tools like RSI, sentiment and breadth. But the next stage of development is recognizing that these metrics behave differently under different market conditions so they can’t just be taken at face value. Among the lessons in this stage is to watch for how a market behaves coming out of extreme oversold conditions.

If the bulls are unable to mount a decisive move, then they’ve betrayed their weakness. That has been the characteristic of this market since April and until it proves otherwise, I would advise caution for those who are long.

And to be perfectly honest, it makes me rather uncomfortable to find myself in disagreement with such giants of technical analysis as NDR and Lowry but since I’m dedicated to thinking for myself and making my own mistakes rather than becoming an automaton, I suppose that is the price that is to be paid.

Enjoyed this? Don't miss the next one, grab the feed or subscribe through email:

Going into the July 09 head and shoulder pattern, the pattern which failed, Lowry was bearish. His reasoing and numbers were solid and convincing. He was wrong and quickly, late July anyway, changed outlook and did his mea culpa. That rally was impressive both in breadth and volume. While breadth was great March and April, convincing volume, the sort that leaves no doubt in anybody’s mind of the market’s intent, has been absent. Additionaly, there is the wsj article that puts texture on canvas in regards to breadth vs. herding. Lowry’s metrics may be getting as fouled as those of us who use breadth, new high/lows, etc.

Matt, certainly possible. If it were as easy as just following Lowry’s demand/supply gauges to guarantee a win, everyone on Wall St. would be doing it. The last time their proprietary indexes went out of sync with the market was also when we had very high correlation among individual stocks (late 2008-early 2009). But don’t you mean the late June (as completion of the H/S pattern?).

Nate, you could be right and I noted as much a few days ago when I wrote about this (S&P 500 Herding Wreaks Havoc On Breadth Indicators). That’s why I keep repeating the simple definition of trend, lower lows and lower highs as well as the resilience in sentiment.

You are absolutely right. Although it was easy to miss day-to-day, the 2009 rally was clearly signaled by higher lows and higher highers. Moreover, although the dips were of varying size, the reversals off the lows were decisively strong.

Now, we are seeing much the opposite play out. The intra-swing moves aren’t as decisive (which might be expected given that downtrends are more volatile in general), but the swings themselves are following a clear pattern.

The trend has clearly turned down, and other than short-term buys off extreme oversold levels, going long may prove to be as futile as going short did in Q2-4 of 2009.

Wes, the ratio of short term breadth to long term breadth flagged the early July low (as did a whole host of indicators like the RSI which I mentioned also). Right now it has moved past that and is at levels which can be more associated with tops than bottoms (it is above 1.0 for the curious).

I think time and price are key here and i really haven’t seen that mentioned by anyone. The market has basically gone nowhere for 2 months after the initial thrust down. this is creating the apperance of a basing partern. Which after a strong sell off I would say is bullish. But that remains to be seen . I’d say if the bears are going to make something happen here it would need to be soon. In 2008 one of the hall marks was price kept making new lows and it was constant. In this market price really has gone side ways . With a small couple day blip outside the bottom of the range and above. This compliments Jason goepherts study on large average true range days after the flash crash. He found it resulted in side ways range for months after almost all those situations except for 1 the resolution was bullish.

Don’t be concerned about those people … they do much the same work at Jim Stack at Investech, who I respect also …. the frequent deflationary bouts this market has to deal with is why they (the GIANTS) are so frequently getting caught AND slammed … you are just trend following this latest deflationary rout. Congrats!